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The Commercial Court was recently asked to consider the correct construction of the phrase “consequential or special losses or expenses” in a clause that distributed (and limited) liability and remedies between parties (Star Polaris LLC v HHIC-Phil Inc [2016] EWHC 2941 (Comm) (17 November 2016)). In distinguishing existing Court of Appeal authority that suggested that such words equate to the second limb of Hadley v Baxendale, the Commercial Court gave the words an expansive meaning that severely restricted the remedies available to the wronged party. The approach adopted by the Commercial Court will be highly relevant to drafters of such clauses across oil & gas, shipbuilding and shipping industries.

Facts

Star Polaris LLC (the “Buyer”) and HHIC-PHIL Inc (the “Shipbuilder” or “Builder”) entered into a contract dated 6 April 2010 (the “Contract”) for the construction of the STAR POLARIS (the “Vessel”). The Contract was a variant of the Shipbuilders Association of Japan (“SAJ”) standard form.

Article IX of the Contract stated:

“ARTICLE IX
1. Guarantee of Material and Workmanship
The Builder […] guarantees the VESSEL and all parts and equipment thereof that are manufactured or furnished by the BUILDER under this CONTRACT or its Subcontractors or its suppliers against all defects which are due to defective materials, design error, construction miscalculation and/or poor workmanship, provided such defects have not been caused by perils of the sea, rivers or navigation, or by normal wear and tear, overloading, improper loading or stowage, fire, accident incompetence, mismanagement, negligence or wilful neglect by the BUYER or by alteration or addition by the BUYER not previously approved by the BUILDER, unless such an event was caused by an act or omissions of the BUILDER.
[…]
3. Remedy of Defects
(a) The BUILDER shall remedy, at its expense, any defects against which the VESSEL is guaranteed under the Article, by making all necessary repairs or replacements at the SHIPYARD, if reasonably practicable or elsewhere as provided for in herein below.
(b) In any cases, removal of the VESSEL to the location at which the repair or replacements are to be effected, shall be at the BUYER’s risk and expenses.
[…]
4. Extent of BUILDER’s Liability
(a) After delivery of the VESSEL the responsibility of the BUILDER in respect of or in connection with the VESSEL or this CONTRACT shall be limited to the extent expressly provided in the Paragraph 4 of this Article. Except as expressly provided in this Paragraph, in no circumstances and on no ground whatsoever shall the BUILDER have any responsibility or liability whatsoever or howsoever arising in respect of or in connection with the VESSEL or this CONTRACT after the delivery of the VESSEL. Further, but without in any way limiting the generality of the foregoing, the BUILDER shall have no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damages or expenses unless otherwise stated herein.
[…]
(d) The liability of the BUILDER provided for in this Article shall be limited to defects directly caused by defective materials, design error, construction miscalculation and/or poor workmanship as above provided. The BUILDER shall not be obliged to repair, nor be liable for, damage to the VESSEL or any part of the equipment thereof, which after delivery of the VESSEL, is caused other than by the defects of the nature specified above. The guarantees contained as hereinabove in this Article replace and exclude any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise on the part of the BUILDER by reason of the construction and sale of the VESSEL for and to the BUYER.”

The Shipbuilder delivered the Vessel to the Buyer. However, during the 12 month warranty period, the Vessel suffered a serious engine failure. The Shipbuilder denied liability and the Buyer commenced arbitration against it for breaches of the Contract and claimed compensation, which included:

During the hearing, the Buyer indicated that it also wished to make a claim for diminution in value of the Vessel.

The Shipbuilder sought to rely upon the exclusion for “consequential or special losses”, as excluding claims for all damages that were not the cost of repair. However, the Buyer argued that “consequential or special losses” only excluded the very narrow category of damages identified in the second limb of Hadley v Baxendale (1854) 9 Ex 341.

Arbitral Tribunal Award

The arbitral tribunal decided that the exclusion of liability for “consequential or special losses, damages or expenses” contained in Article IX of the contract excludes liability for all losses (including financial loss consequent upon physical damage) except the obligation to remedy any defects by making all necessary repairs and replacements. In that context, “consequential or special losses” had a wider meaning than in the second limb of Hadley v Baxendale.

Commercial Court Decision

The Buyer appealed against award.

The Buyer argued that:

The words “consequential loss” have an established meaning as a matter of law, which is the second limb of Hadley v Baxendale. Whilst it had been questioned whether should be correct, it is the subject of Court of Appeal authority and must be applied by the High Court.

In the context of the clause in question, the words “consequential loss” appear with the words “special losses”. The authorities show that “special losses” are also the second limb of Hadley v Baxendale.

Additional words deleted from the SAJ form would have excluded ‘loss of use’. It would therefore be wrong to construe the Contract as a complete code excluding all losses except the cost of repair.

The Commercial Court rejected the Buyer’s arguments and upheld the arbitral tribunal’s award. In reaching the decision the Commercial Court reasoned that:

A. Notwithstanding any authorities, a clause fell to be construed on its own wording and in the contract of the contract in dispute;

B. it can no longer be said that exclusion clauses are to be read narrowly when they appear in commercial contracts – the wording must be given its natural and ordinary meaning – where there is ambiguity the contra proferentum rule may play a role;

C. the last sentence of Article IX.4(d) makes plain that Article IX provided a complete code for the determination of liability;

D. once it is accepted that Article IX of the contract provides a complete code for the determination of liability, the issue is “not therefore a question of simply determining what liability is excluded, but ascertaining what liability is undertaken”;

E. because Article IX sets out a complete code, the only express provision in Article IX.4 of responsibility and liability post-delivery of the Vessel is the liability in Paragraph 4(d) for defects. Further, that liability can only refer to Article IX.3 and the obligation to repair physical damage; and

F. it was therefore also necessary to read the words in Paragraph 4(a) “except as expressly provided in this Paragraph” as “except as expressly provided in this Article”, as they were a reference to the remedies in Paragraph 3 – otherwise there would be no express provision for liability.

The only positive obligations assumed under the guarantee were the repair or replacement of defects and physical damage caused by such defects.

Further, the Commercial Court decided that the reference to “consequential or special losses, damages or expenses” in Article IX of the Contract did not mean such losses, damages or expenses as fall within the second limb of Hadley v Baxendale but does have the wider meaning of financial losses caused by guaranteed defects, above and beyond the cost of replacement and repair of physical damage. The claim for diminution in value was also considered to be a claim for “consequential or special loss” and was therefore excluded (even though it might well have fallen within the first limb of Hadley v Baxendale).

Comment

The arbitral tribunal and the Commercial Court appear to have been strongly influenced by the fact that it was considered common ground between the parties that Article IX was a complete code which meant that, in order to succeed, the Buyer had to bring its claim within its terms. The exact scope of the Buyer’s concession is not apparent from the judgment.

However, once it was accepted that Article IX was a complete code, the scope of the “consequential or special loss” exclusion was deemed somewhat secondary to the Buyer’s need to identify an ‘inclusive remedy’ under which it may make a claim. Absent such express right, no claim could be sustained.

From a drafter’s perspective, the Commercial Court’s decision highlights the difference between seeking to create a complete code, where all remedies must be expressly identified, and seeking to exclude common law remedies, where the clear words are likely needed to achieve an exclusion of a remedy.

That said, the decision does raise some interesting issues for construction of “consequential loss” exclusion clauses:

The decision intimates that following Transocean Drilling v Providence Resources [2016] EWCA Civ 372, English law will no longer read exclusion clauses agreed between commercial parties narrowly (it is of interest in this regard that Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] A.C. 689 was not even cited by the Commercial Court); and

the decision suggests that the emphasis that English law places the words used by the parties, viewed against the relevant factual matrix, means that legal authorities concerning the meaning of the words “consequential loss” in the context of a contractual clause distributing risk should be viewed with care and might not apply to all contracts.

It is apparent that the debate about the scope of exclusions generated by ‘consequential loss’ clauses remain very much post-Transocean Drilling v Providence Resources. Lord Hoffmann queried in Caledonia North Sea v British Telecommunications [2002] UKHL 4 whether the Court of Appeal cases that equate the words ‘consequential loss’ in contracts to the second limb of Hadley v Baxendale are correct. In fact, Lord Hoffmann questioned the whole premise of Hadley v Baxendale: “although an excellent attempt was made in Hadley v Baxendale to lay down a rule on the subject, it will be found that the rule is not capable of meeting all cases; and when the matter comes to be further considered, it will probably turn out that there is no such thing as a rule, as to the legal measure of damages applicable in all cases.” (Hoffmann, The Achilleas: custom and practice or foreseeability? (2010) 14(1) Edin. L.R. 47-61).

It remains to be seen whether the Commercial Court decision in this case is followed. However, it appears to add an additional lawyer of uncertainty and complexity to an already knotty area of English law. In the interim, drafters should continue to be cautious of using phrases like ‘consequential loss’ without defining their meaning.